China’s historic rise (or slowdown)

HONG KONG – Is China on the brink of eclipsing the United States as the world’s economic megapower, with the yuan taking over from the dollar as the global currency, and China able to exercise financial, military and political hegemony?

Or is China’s economic growth about to slow to 3 percent a year as the country is forced to change its growth model?

These two contrary views have been published by reputable economists recently. Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, believes that the rise of China is unstoppable and so is the decline of the United States.

On the other hand, Michael Pettis, an economics professor at Peking University, predicts potholes and twists ahead on China’s development road along with 3 percent growth coming soon.

Subramanian writes from the safe distance of Washington. Earlier this year he contended that on an accurate purchasing power basis, China’s economy may already be bigger than the U.S.

He carries his argument further in an article in Foreign Affairs to be followed by a book later this month, projecting both the inexorable rise of China and the inevitable decline of the U.S., with dire consequences on the way for Washington.

He makes a good point about the importance of economic power. He says it offers “the ability of a state to use economic means to get other countries do what it wants or to prevent them from forcing it to do what it does not want. Such means include the size of a country’s economy, its trade, the health of its external and internal finances, its military prowess, its technological dynamism, and the international status that its currency enjoys.”

He has developed an “index of dominance” using three factors and data going back to 1870 — gross domestic product, total trade, and the extent to which a country is a net creditor to the rest of the world. Subramanian acknowledges economic distortions that will cause China’s economy to slow, including an aging population, overly cheap capital leading to excessive investment, an undervalued exchange rate and subsidized energy, but he forecasts growth for China over the next 20 years of 7 percent a year on average.

For the U.S., Subramanian says 2.5 percent a year is feasible, more optimistic than the 2.2 percent forecast of the Congressional Budget Office.

It is not difficult to do these sums: Even if the U.S. is a bigger economy now, it won’t be for long. By 2030, Subramanian predicts, China will be much bigger with 20 percent of global GDP, against 15 percent for the U.S. Even in per capita terms Chinese income will be a respectable $33,000, more than half that in the U.S.

In trade, he forecasts, China will be still more dominant, generating twice as much as the U.S., while China’s muscle as a creditor will be important. Forget a multipolar world, writes Subramaniam: This will be China’s unipolar globe.

On the U.S. side, Subramanian is undoubtedly correct that Washington has big problems — which were only underlined again by unemployment statistics showing jobless figures of 9.1 percent even two years into a so-called recovery. The dynamics are damning for the U.S., and Subramanian is right to underline the multiple weaknesses of the American economy.

He writes grimly: “Repeated tax cuts and two wars, the financial and economic crisis of 2008-2010, the inexorable growth of long-term entitlements (especially related to health), and the possible buildup of bad assets for which the government might eventually be responsible have created serious doubts about the U.S. public sector’s balance sheet.

“High public and private debt and long-term unemployment will depress long-term growth. And a combination of stagnating middle-class incomes, growing inequality, declining mobility and, more recently, falling prospects even for the college-educated has created big distributional problems.”

Pettis’ perspective, informed by actually living and working in Beijing, is different. In a blog dated Aug. 28 and devoted to a number of predictions on a worldwide basis, he forecasts that Chinese consumption, an almost unthinkably low 35 percent of GDP, is set to fall. He says this will happen in spite of growing official recognition about the dangers of China’s economic imbalances.

He points out: “Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies — low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates — that have generated (China’s) furious GDP growth.”

He comments that for all its unease, Beijing has not acknowledged that it needs to change its growth model. So, Pettis predicts that, for the next 15 months, Chinese debt levels will rise quickly in spite of attempts to slow their growth because Beijing is focusing on specific areas, not on the overall tendency to produce debt. As in a game of whack-a-mole, local government spending will be reined in, but will appear in other guises, such as locally controlled state-owned enterprises (SOEs).

“By 2013-2014,” Pettis forecasts, “Chinese GDP growth will slow sharply, and by 2015-2016, predictions of a sustained period of growth rates at 3 percent or lower will no longer seem outlandish.” In spite of this, he disagrees with economists who believe that China has to achieve growth of 8 percent plus in order to maintain full employment and thus social and political stability.

Pettis contends that even growth of 3 percent would be acceptable if — and it is clearly a big if — the growth is better balanced. If China gets away from its heavily capital-intensive model — “wholly inappropriate for such a poor country” — and sharply reduces free credit to SOEs and local governments and makes credit available for small- and medium-size enterprises and for the service sector, both of which are more labor-intensive, then China can happily live with lower growth without social or political upheaval.

The big political question is will China try to rebalance its economy?

Pettis argues that China “has no choice unless it has infinite borrowing capacity and the world has infinite appetite for Chinese surpluses”.

But Subramanian points out that China is already showing its economic muscle in refusing to revalue the renminbi and not hearing much in the way of protest from affected countries from Brazil to India.

Pettis also makes a highly pertinent point that applies to China: “The elites that benefit from economic distortions are traditionally the ones most likely to prevent necessary adjustments, and if they actually run the whole show, adjustment can be incredibly painful and disruptive.”